A Tiny Trading Adjustment That Has Enormous Implications

Often Overlooked

Much of a trader’s time is spent searching for setups. This is often exercised as a primary objective, which it is. However, a great setup that is not accompanied by another very important aspect can very easily become a disastrous trade. You might wonder how that is even possible, and yet it is. Every trader has their own set of rules to follow in identifying a viable trade.

At the end of the day, certain dynamics need to line up if a trade is to carry a high probability of success. For instance, here is a 5-step test published by Investopedia. Once all 5 boxes are ticked, the likelihood of a successful trade is relatively high, according to this article. As I said, every trader will have their own unique method and test.

You will however find that most “identifying” strategies will share similar key aspects. However, they may vary in other areas. The type of trade is also very important. Are you opening a scalp trade, swing trade, or intra-day trade? These are all very important aspects to consider when establishing and setting a stop loss for your desired trade.

Make Or Break

Yes, the all-important stop-loss that so often gets ignored, and yet plays a massive role in the success or failure of a trade. Let me explain, depending on your time frame, a stop-loss needs to accommodate a certain amount of volatility. Choosing to set a stop-loss with a low percentage trigger on a swing trade can literally disqualify you from experiencing an otherwise successful trade.

A swing trade plays out on higher time frames, which means that the price action on higher time frames moves in larger percentage increments. This actually requires a study of the previous price action, in order to effectively place a stop-loss. Having a set stop-loss in terms of a percentage-based trigger, as opposed to a price-action-based trigger might not actually be the best idea.

For instance, setting a stop-loss at 1.5% when the previous price action reveals that a safe retracement zone is actually 2% means that you are going to get unnecessarily stopped out. You will note that often before a large move, either way, there is a swift counter move. This is a final sweep to trigger stop-losses and capture more liquidity.

You have to factor in stop-loss hunting, and this can often be done by studying past performance. Identifying retracement zones in relation to their percentage values is extremely helpful in discovering that “sweet spot”.

The Flipside

A similar problem can also exist in providing too much leniency for a stop-loss. In such a scenario, a failed trade now costs a trader a lot more than it should or is acceptable. Every trader needs to establish a healthy ratio in terms of a failed trade versus a successful trade. If the profitability margin of a successful trade is not significant enough, failed trades will hinder overall profitability.

Once again, it’s about finding that “sweet spot” where the numbers make sense. Trading is a game of probabilities, as well as the law of averages. Find the correct mix and you will have a formula for consistent profitability, ultimately enabling you to generate a trading income.

Final Thoughts

This is a crucial aspect of trading that so many choose to overlook, or at least, don’t take seriously enough. Making use of a demo account is also a great way way to test the application of your stop-loss process. That’s it for this one, see you next time!

Leave a Reply

%d bloggers like this: